Below, we offer our analysis of calendar fourth-quarter earnings for three Portfolio names: Artis REIT (TSX: AX-U, OTC: ARESF), PennantPark Investment Corp (NSDQ: PNNT), and Student Transportation Inc (TSX: STB, NSDQ: STB). We may have time for one more round of updates prior to the next issue, and, if not, we’ll include additional updates in the issue itself.

Manitoba-based Artis REIT (TSX: AX-U, OTC: ARESF) is a diversified real estate investment trust (REIT) that’s built a portfolio of commercial property with high-quality tenants that’s diversified both geographically, with properties in the US and Canada, as well as in terms of its holdings, which consist of office, industrial and retail properties.

At year-end, the breakdown of its portfolio in terms of property net operating income (NOI) was 25.6 percent retail, 50.5 percent office, and 23.9 percent industrial, with Canadian properties accounting for 80.1 percent of the portfolio and US properties the balance. Though the pace of acquisitions is slowing, as we discuss further below, Artis’ long-term strategy calls for US properties to increase to as much as 30 percent of the portfolio.

The percentage of Artis’ portfolio under lease in terms of both occupancy and commitments on vacant space, ticked lower by a tenth of a point at year-end, to 96.2 percent, compared to a year ago. But that’s consistent with its performance in recent years and compares favorably to its peers.

During the fourth quarter, the CAD1.98 billion REIT saw its NOI increase by 12.5 percent, to CAD75 million, versus the year-ago period, while same-property NOI rose 3.7 percent. Artis grew funds from operations (FFO), the primary metric of a REIT’s profitability, by 15.3 percent, to CAD45.4 million, versus the year-ago period.

Adjusted funds from operations (AFFO), which is FFO net of allowances for normalized capital expenditures and leasing costs and excludes straight-line rent adjustments and unit-based compensation expense, climbed 13.4 percent, to CAD38.5 million.

On a per-unit basis, diluted FFO increased by 2.9 percent, to CAD0.35, while diluted AFFO was flat, at CAD0.30. The payout ratio based on FFO improved by 2.3 percentage points, to 77.1 percent,  while the AFFO payout ratio remained at 90 percent.

For full-year 2013, NOI grew 23.5 percent, to CAD296.9 million, while FFO jumped 30.9 percent, to CAD183.5 million. However, the REIT conducted a secondary equity issuance last May that increased units outstanding by more than 10.4 million, so these results shrink when adjusted on a per-unit basis.

Diluted FFO per unit climbed 12.3 percent, to CAD1.46, while diluted AFFO per unit increased 9.6 percent, to CAD1.26. Both payout ratios declined, with the FFO payout ratio dropping 9.1 percentage points, to 74 percent, and the AFFO payout ratio falling 8.2 percentage points, to 85.7 percent.

During the year, Artis acquired 13 properties for CAD533.5 million in the US and Canada, a majority of which was office space. It also sold two industrial properties for which its net proceeds were CAD11.3 million. The REIT ended the year with a portfolio of 232 investment properties, totaling nearly 25 million square feet, valued at nearly CAD4.9 billion, up 14.8 percent from a year ago, and with a capitalization rate of 6.41 percent.

There were no acquisitions during the fourth quarter, and management expects the pace of deals to slow until REIT unit prices, property capitalization rates, and interest rates stabilize. As we detail further below, the US Federal Reserve’s decision to taper caused a sudden spike in bond rates and a corresponding decline in dividend-paying equities, such as REITs.

The REIT’s schedule of expiring leases is staggered over the next four years, with an average of 12.7 percent of total square footage per year coming off contract during this period. The weighted average term to maturity among all of its leases is 4.7 years, while the average lease among its top 20 tenants, which account for 19.4 percent of gross revenue, doesn’t expire for another 7.4 years. Management has already secured renewals or commitments for 36.3 percent of the 2014 expiries.

In 2013, the weighted average rental rate increase was 7.2 percent versus 2.6 percent in the prior year. For 2014, the company’s analysis shows that in-place rents are priced about 7.1 percent below market, which suggests rents among expiries could rise by a similar percentage this year.

Artis is making progress toward reducing its leverage. Its total long-term debt to gross book value stands at 49 percent, down 2.5 percentage points from a year ago. Meanwhile, the cost of existing debt remains manageable, with the weighted average interest rate on mortgages and other loans at 4.27 percent, down 15 basis points from last year.

In preparation for rising rates, management has moved to hedge its floating-rate debt, with the unhedged portion of these obligations now at 10.2 percent of total debt, down 5.6 percentage points from a year ago.

In terms of liquidity for funding continuing operations as well as financing future acquisitions, the REIT ended the year with CAD48 million in cash on its balance sheet and has another CAD80 million available from its credit revolver.

On Bay Street, analyst sentiment remains largely bullish, with six “buys,” three “holds,” and no “sells.” The consensus 12-month target price among the six analysts for which we have recent data is CAD17.04, which suggests potential appreciation of 9.1 percent above the current unit price.

Analysts forecast FFO per unit will remain flat for full-year 2014, but rise by 3 percent, to CAD1.50, in 2015.

Artis’ units closed at a two-year low in early September, at CAD13.45, as investors fled REITs and other income-oriented equities due to fears that eventual Fed tightening would compel retail investors to abandon such securities in favor of fixed income.

However, the Fed is unlikely to allow rates to rise too much until there’s greater evidence of a resurgent economy. Nevertheless, assuming such a rebound is indeed underway, the cost of borrowing to expand REIT assets will be higher, and dividend-paying securities will face increased competition from fixed income.

This will force Artis to retreat from the external growth it’s pursued over the past several years thanks to the abundance of cheap financing amid historically low interest rates. In the past, the REIT has done about CAD300 million to CAD600 million in acquisitions per year. But this year, management believes that number could come in at a lower range, between CAD100 million to CAD300 million.

Fortunately, the REIT should enjoy greater organic growth, not only from refocusing on improving internal operations, such as by redeveloping existing properties or pursuing intensification, but also because a stronger economy usually translates into the ability to charge higher rents.

On a price basis since the earlier low, Artis’ units have risen 16.1 percent in local currency terms and 8.5 percent in US dollar terms. This compares favorably to the Bloomberg Canadian REIT Index (BBCREIT), which hit its two-year low around the same time, and has since climbed 5.9 percent in Canadian dollar terms, but declined 1.1 percent in US dollar terms.

Over that same period, the S&P/TSX Composite Index (SPTSX) gained 11.3 percent in local currency terms and 3.9 percent in US dollar terms, while the  S&P 500 rose 12.3 percent, and the Bloomberg NA REITs Index (BBREIT), which tracks US REITs with market caps of USD15 million or greater, increased by 5.5 percent.

Over the period since we first recommended Artis in late August, the units have gained 17.7 percent on a total-return basis in local currency terms and 11.5 percent in US dollar terms.

That performance beat the 2.9 percent return of the BBCREIT in US dollar terms, as well as the 7.9 percent gain of the SPTSX. It also surpassed the BBREIT’s 8.3 percent return, though it slightly lagged the S&P 500’s 14.1 percent gain.

The REIT’s CAD0.09 monthly distribution hasn’t budged since mid-2008. Management has stated that it would like to get its AFFO payout ratio down to 80 percent and its total debt to gross book value down to 45 percent before it will consider increasing the distribution, especially considering the higher cost of capital down the road.

But the payout is well covered at current levels and offers an enticing yield of more than 6.9 percent. Artis REIT remains a buy below USD16.

PennantPark Investment Corp (NSDQ: PNNT) was our inaugural recommendation when we took the helm of this service last May. At the time, in reviewing some of the past picks under the prior editors, we noted that a number of Portfolio Holdings had suffered tremendous downward volatility. Of course, the high-yield equity space is supremely challenging in this regard, since you don’t get outsized payouts without commensurate risk. Nevertheless, our hope has been to find names that would more or less hold their value over the medium to long term, while maintaining a high payout.

Thus far, PNNT has been almost a textbook example of such consistency. Though the shares have traded as high as $12.10 and as low as $10.45, the average price during our holding period has been $11.38, just below the initial price at which we added this business development company (BDC) to the Portfolio. Of course, we’d be glad to have some price appreciation as well, and we believe that will happen eventually. In the interim, we’ve been amply compensated for our patience by collecting the quarterly payout, which still yields roughly 9.9 percent.

But one of our concerns in recommending a BDC had been that any shift in Federal Reserve monetary policy could pose significant challenges to this rate-sensitive sector. We’re still betting that monetary policy will be looser longer than some expect. But the curtailment of the Fed’s extraordinary stimulus means that BDCs have lagged the broad market since we added PNNT to the Portfolio, with the Wells Fargo BDC Index (WFBDC) up 7.4 percent on a price basis versus 13.8 percent for the S&P 500.

At the outset of our recommendation, one of the areas that we mentioned would cause us to revisit our original thesis is whether the company starts to fully cover its payout again. Management does have substantial credibility with regard to the sustainability of its distribution, given that PNNT was one of just two BDCs that didn’t cut its payout during the Great Recession. Still, our comfort would be greater if its net investment income (NII) managed to fully cover its distribution.

Back in May, when we first recommended the stock, PNNT was fresh off a quarter in which a couple of one-time items caused NII to fall significantly short of full coverage, with NII per share of $0.21 versus a quarterly distribution of $0.28. Even when NII was adjusted for those two items, it still was three cents shy of the payout. In the three quarters for which PNNT has reported since then, NII per share came in at $0.27 and $0.26 for the calendar second and third quarters, respectively, while in the calendar fourth quarter, the company reported $0.27 per share.

So that’s four straight quarters in which PNNT has under-earned its distribution. Of course, that’s happened before, during the Great Recession. And most BDCs fail to fully cover their distributions once or twice per year. But at the very least, the company has made progress toward this threshold, and we’re willing to continue holding.

Management reports that there’s still significant demand for the middle-market financings in which it specializes, so the firm is able to remain very selective in its underwriting. The disciplined investment team focuses on lending to companies that operate in defensive areas of the economy, generate strong cash flows, boast competitive advantages, have low leverage and are guided by experienced management teams. In a sense, management’s goal is the same as ours: Find the least risky investments in an otherwise highly risky investment environment.

Despite investing in second lien and subordinated financings, the company’s superior underwriting is evident in its long-term record: PNNT has had only seven non-accruals out of 380 investments since its 2007 inception, and currently has no non-accruals on its books. At quarter-end, the company’s portfolio was divided among the following types of securities: 26 percent in senior secured debt, 34 percent in second-lien secured debt, 29 percent in subordinated debt and 11 percent in preferred and common equity.

During PNNT’s fiscal first quarter (ended Dec. 31), the company invested $228 million, its largest origination activity since prior to the downturn, with net new investments of $84 million, at an average yield of 12.4 percent. Seven of the companies in which it invested were existing portfolio names, while nine were new to the portfolio, with the overall portfolio now invested in 66 names operating in 28 different industries.

The company has considerable liquidity with which to pursue future investments, including $190 million available from its credit facility, $75 million in financing from the Small Business Administration (SBA) through its Small Business Investment Company (SBIC) program, and more than $30 million in cash on its balance sheet.

Over the past four quarters, PNNT’s investment portfolio has grown in value by 8.5 percent, to $1.2 billion, while the yield on its debt investments at quarter-end was 13.2 percent, down a tenth of a point over that period. Meanwhile the net asset value per share has grown 2.9 percent, to $10.80. Based on yesterday’s close, the firm trades at about a 5.1 percent premium to NAV.

Though PNNT beat analyst estimates on sales, met the consensus on NII, and analyst sentiment remains largely bullish, at eight “buys” and five “holds,” expectations for future price appreciation remain muted. The consensus 12-month target price is 11.80, which suggests potential increase of just 4.3 percent above the current share price. But again, that’s consistent with the slow grower we expected at this juncture in the cycle.

For 2014, management expects active deal flow thanks to financings for both growth and mergers and acquisitions. PNNT remains a buy below 11.50.

Despite the harsh winter weather and its attendant labor and maintenance costs, Student Transportation Inc (TSX: STB, NSDQ: STB) reported that fiscal 2014 first-half (ended Dec. 31) revenue grew 15.3 percent, to USD208.7 million. Though STB had to absorb the increase in expenses as a result of a colder-than-usual season, any revenue missed in the recent quarter due to school closings will be made up in its fiscal third and fourth quarters, since most of the company’s contracts specify 180 days of school service and that’s when schools typically make up for lost days.

Interestingly, management noted that the company’s reputation for reliability during such weather extremes could earn it two new contracts from school districts fed up with a contractor that underperformed during snow events. Indeed, this dependability has helped earn STB a high renewal rate on its contracts, typically around 97 percent.

Meanwhile, the CAD627 million company generated adjusted EBITDA (earnings before interest, taxation, depreciation and amortization) of USD29.5 million, up 18.2 percent, driven by two tuck-in acquisitions and nine contract wins. The nine new contracts added 1,000 vehicles to the company’s fleet, and included the company’s largest contract award to date.

As a side note, though STB is a Canadian company, it reports its financials in US dollars.

Revenue for the fiscal second-quarter (ended Dec. 31) rose 13.5 percent, to USD135.5 million, while adjusted EBITDA increased 8.7 percent, to USD30.9 million. Those with an attention to detail will note that STB’s calendar fourth-quarter EBITDA was slightly lower than the full six-month period. That’s attributable to the seasonality of the industry, as the calendar third quarter, includes two essentially idle months, July and August, prior to the beginning of the traditional school year.

Adjusted EBITDA offer a truer measure of operational cash flows, as STB incurs huge depreciation expenses from its massive bus fleet–USD13.4 million in its most recent quarter. Since these and other non-cash expenses don’t reduce the actual cash the company generates, it makes sense to add them back to net income to get a better sense of operations as well as dividend coverage. Based on adjusted EBITDA, the company’s payout ratio for the first half of fiscal 2014 was 59 percent.

STB has also made strides toward reducing its fuel expense, with that item decreasing as a percentage of revenue by six-tenths of a percentage point year over year, to 8.0 percent. The company has fuel-mitigation features in about 60 percent of its contracts with school districts, while it’s covered about 23 percent of its commodity exposure for fiscal-year 2014 via fixed-price contracts with fuel suppliers.

Management’s medium- to long-term goal is to pare fuel expense to a range of just 6 percent to 6.5 percent of total revenue, by adding more propane-fueled vehicles (roughly 10 percent of its fleet at present), as well as by negotiating customer-paid fuel contracts.

At quarter end, STB had USD3.3 million in cash and cash equivalents on its balance sheet, along with USD273.6 million in long-term debt, with maturities staggered over the next several years. In November, the company raised USD71.4 million from 6.25 percent convertible debentures due June 30, 2019.

On Bay Street, the current mix of analyst sentiment is two “buys,” three “holds,” and one “sell.” Analysts forecast the company’s full-year fiscal 2014 (ending June 30) earnings per share (EPS) will decline 8 percent, to USD0.05, on revenue growth of 15 percent, to USD485.8 million. But the following fiscal year, EPS is projected to jump 48 percent, to USD0.07, while revenue will climb 10 percent, to USD534.4 million.

The consensus 12-month target price is CAD7.48, which suggests potential price appreciation of 6.7 percent above the current share price.

STB still has substantial opportunity for growth by winning new contracts with school districts, as well as by pursuing a consolidation strategy. Roughly 66 percent of the more than 500,000 North American school buses are owned and operated by public school districts, while the private-sector industry that covers the balance is highly fragmented, with an estimated 4,000 companies.

In the US, about 70 percent of the total fleet of nearly 468,000 buses is owned and operated by school districts. Of the 30 percent handled by the private sector, the top 10 contractors account for about 72.5 percent of that total.

STB ranks third on this list, with its fleet of 9,500 buses nearly double that of its fourth-ranked competitor, Atlantic Express Transportation Corp, while it’s dwarfed by its two largest competitors, National Express Corp and First Student Inc, which own and operate 21,000 buses and 54,450 buses, respectively. STB’s operations in both the US and Canada now include 10,800 vehicles, of which leased and managed buses account for about 19 percent and 4 percent of the total fleet, respectively.

School budgets have been constrained in recent years, and that has helped prompt administrators to save money by contracting this service to third parties. As National Association of Pupil Transportation President Don Carnahan observed in a recent interview with School Bus Fleet, one of the industry’s leading trade publications, school districts have not only had to contend with higher fuel prices over the past decade, but also the higher cost to replace an aging fleet. Recent clean-air regulations, in particular, have substantially raised the cost of compliance, and bus manufacturers are passing that along to their customers.

According to School Bus Fleet, the average age of the US fleet is rising, and now stands at 9.3 years, with an average retirement age of 14.4 years for large school buses in areas where roads are salted and 19.3 years in areas with no salt.

One of the novel ways in which STB is addressing school districts’ aging fleets is with its municipal tax lease program, whereby it helps districts arrange lower-cost financing for new buses, while the company handles operating and managing the fleet.

However, this new fiscal austerity has also caused a decline in school bus services, as districts seek savings by making cuts in student eligibility for transportation services. Fortunately, based on the magazine’s survey data, only 8 percent of respondents expect cuts to service in the coming year, down sharply from 21 percent and 15 percent in 2011 and 2012, respectively.

Since quarter-end, STB has continued to win new contracts and acquire additional transportation assets. In early January, it entered into a management services agreement with the aforementioned Atlantic Express (AE), whereby STB subsidiary SchoolWeels Direct Inc would manage AE’s school transportation operations in California.

AE’s parent company had previously sought bankruptcy protection, and in early February, a month into the management agreement, the company’s debtors cleared STB to acquire the California assets it had only just begun managing. The deal includes 425 school vehicles, which generate USD26 million in annualized contracted revenue.

Then in late February, STB was awarded three new contracts in upstate New York. The contracts, which include customer-paid fuel, commence at the beginning of the next school year and will generate USD7 million in annualized revenue.

STB has held its monthly payout at an annualized rate of CAD0.56 since its first dividend declaration in October 2006. At recent prices, the shares yield 7.9 percent. Student Transportation is a buy below USD7.